Opinion by: Jason Delabays, blockchain ecosystem lead at Zama
Even with the recent revival of decentralized finance (DeFi), a significant portion of traditional finance’s capital remains inaccessible. While scalability, regulation, or user experience are often cited as barriers, the core issue is a fundamental lack of confidentiality. Address this, and untold trillions could be unlocked.
At its peak in December 2021, DeFi’s total value locked (TVL) reached an impressive $260 billion. However, when viewed in the context of the global financial system, that number appears relatively small—especially given that foreign exchange transactions alone exceed $7.5 trillion each day, and the global bond market is valued at over $130 trillion.
Since the crash of 2022-2023, DeFi has rebounded, with lending protocols demonstrating resilience and TVLs on the rise. Yet, DeFi is still only tapping into a tiny fraction of global capital, not due to scalability issues, but rather the absence of an essential element that traditional finance requires.
Encryption technology overcoming major challenges
For many institutions and high-net-worth individuals, confidentiality is crucial. Every transaction—whether it’s a deposit, loan, or withdrawal—is visible on public blockchains. While this transparency excites crypto enthusiasts, it deters serious capital from participating.
This is why the vision of realizing DeFi’s potential—seamless, open, institutional-grade finance—still feels far-off for many. However, recent advancements in Fully Homomorphic Encryption (FHE) indicate that this reality may be closer than anticipated.
FHE has transitioned from an academic novelty to a widely recognized technology.
This privacy-preserving tech allows data to be processed without ever decrypting it—sensitive information stays encrypted even while in use. This could entice institutions to enter the DeFi space while keeping their trades and holdings confidential.
Uncollateralized lending and beyond
Take uncollateralized lending, which is one of the clearest potential applications for FHE in DeFi and reflects how credit functions in traditional finance. Whereas traditional finance rarely requires overcollateralization, DeFi does, locking up assets to mitigate risks and thus limiting its potential.
FHE alters this dynamic. Here’s a possible scenario: A user provides encrypted credit or Know Your Customer (KYC) data to a protocol. A smart contract verifies this information using FHE—asking questions like, “Is their credit score above 700?”—all without decrypting it. If the user is approved, they can borrow without collateral while maintaining confidentiality. In the event of a default, the lender might have the authority to decrypt specific information for offchain legal recourse.
In this sense, institutions evaluating risk and providing credit could finally engage in the onchain space without compromising privacy or exposing client information.
This privacy-focused lending could enhance DeFi’s flexibility, inclusivity, and alignment with traditional finance. Uncollateralized lending is merely the beginning. FHE can pave the way for reimagining the foundations of DeFi lending.
Imagine today’s leading protocols reengineered with confidential ERC-20 tokens at their core. Layer on encrypted credit scores, undisclosed loan amounts, and protection against maximal extractable value (MEV). This would not be just an upgrade but a transformation of lending itself.
Related: SingularityNET and Mind Network bring encryption to AI agents
For institutions, this could create private collateral pools with undisclosed positions and the option for credit-based lending. Retail users could access loans without collateral, shielded from front-running and MEV bots. Lending protocols could evolve into confidentiality-first systems capable of scaling to trillions while maintaining trustlessness.
Public blockchains inherently excel in openness and interoperability compared to private ones. However, private chains traditionally provide better confidentiality, making them appealing to data-sensitive institutions. With FHE, public blockchains might achieve confidentiality equivalent to private chains without sacrificing their inherent advantages.
Challenges to overcome, but no reason to give up
All these prospects sound promising, but to truly scale DeFi and attract the trillions stuck in traditional finance, more than just private credit scores and confidential lending pools are required. A whole new infrastructure must be constructed, and several design challenges need addressing, such as liquidations. Encrypted values can complicate liquidation triggers. While FHE allows for comparisons, discreetly notifying liquidators might necessitate encrypted events or offchain relays.
Credit systems present their own challenges. Structuring encrypted KYC and enforcing defaults will require legal and technical coherence; the key is reconciling confidentiality with accountability.
Further enhancements are needed for MEV protection as well. While obscuring transaction amounts is a great first step, pairing these encrypted values with batching or time-locks to further disguise patterns may be essential for comprehensive defense.
Liquidity is impacted too; cWETH separates from Wrapped Ether (WETH), but yield incentives or fluid wrappers might bridge this divide. On the user experience front, decryption tools must be kept simple.
Lastly, oracles introduce a unique dilemma. While public prices might suggest values, FHE-compatible oracles could address this in the future.
None of these hurdles are insurmountable but rather complex challenges. They must be resolved before DeFi can fully realize its potential. Institutions will remain reluctant to engage if every transaction is transparent, and retail users should not have to sacrifice privacy or overcollateralize to secure credit. Given the rapid progress in FHE, the vision of DeFi offering efficiency, Swiss-bank-level confidentiality, and real-world credit—all onchain—could be closer than we think.
Opinion by: Jason Delabays, blockchain ecosystem lead at Zama.
This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
